AnchorBank, FSB et al v. Hofer

Filing 60

ORDER granting 52 Motion to Dismiss. Signed by Magistrate Judge Stephen L. Crocker on 8/31/10. (rep)

A n c h o r B a n k , FSB et al v. Hofer

D o c . 60

IN THE UNITED STATES DISTRICT COURT FO R THE WESTERN DISTRICT OF WISCONSIN

ANCHORBANK, FSB, and P L U M B TRUST COMPANY, on behalf of all AnchorBank Unitized Fund Participants, P l a i n t i f fs , v. C L A R K HOFER, D efend an t.

O P IN I O N and ORDER 09-cv-610-slc

P la in t if f s AnchorBank, FSB and Plumb Trust Company contend that defendant Clark H o f e r manipulated the stock market by orchestrating large trades of units of the AnchorBank U n it iz e d Fund, which led to large trades of stocks for AnchorBanCorp of W i s c o n s i n , Inc. P l a in t if f s are asserting federal claims under §§ 9(a) and 10(b) of the Securities Exchange Act of 1 9 3 4 (15 U.S.C. §§ 78i(a) and 78j(b)) as well as claims for violation of W is c o n s in securities law, b r e a c h of fiduciary duty and unjust enrichment. Following dismissal of their first amended c o m p la i n t for pleading defects, plaintiffs filed a second amended complaint, which defendant also h a s moved to dismiss. F o r the reasons stated below, I am granting defendant's motion to dismiss with respect t o the federal claims. I am declining to exercise jurisdiction over the remaining state law claims p u r s u a n t to 28 U.S.C. § 1367(c)(3). P l a i n t i f f s concede that their theory of liability under federal securities law is "novel." T h a t 's not entirely their fault: defendant's alleged tactics of using the fund to manipulate the m a r k e t are unusual. 1 In a nutshell, plaintiffs allege that defendant and two co-schemers unfairly lin e d their pockets by coordinating a series of burgeoning trades of Fund shares.2 These shares

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Defendant reports that he found no cases with sim i l a r facts; neither did this court. The alleged fraud scheme is detailed in the M a r c h 5, 2010 order, dkt. 49, at 2-5.

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w e r e tied to stocks in the sense that the Fund consisted of AnchorBanCorp stocks and cash, and w h e n the Fund's sales or purchases of funds upset the Fund's cash-to-stock ratio, the Fund would e n t e r the m a r k e t to buy or sell stock so as to restore the ratio. A more run-of-the-mill case of m a r k e t manipulation might involve a hypothetical plaintiff who bought or sold stock in the wake o f a defendant having bought or sold excessive amounts of stock to manipulate stock values; our h y p o t h e t i c a l plaintiff either would buy "too high" or sell "too low" because defendant's

t r a n s a c t io n s had created a price wave that did not represent the true market value of the stock. I n the instant case, market manipulation results from excessive sales of stock by the Fund (which p l a i n t i f f s represent), not by the defendant. The Fund, bound by its mandated cash-to-stock ratio r a n g e , was a tool used by defendant and his abettors to manipulate the market. A s explained in the first dismissal order, for plaintiffs to get past first base on their federal c la im s , their complaint must include: particular facts describing the alleged securities fraud, as r e q u ir e d under Fed. R. Civ. P. 9(b); particular facts supporting a "strong inference" of scienter; f a c t s supporting an inference that the alleged fraud caused an economic loss to plaintiffs; and f a c t s supporting an inference that plaintiffs relied to their detriment on the alleged fraud. Dkt. 4 9 , at 5, 7-8. I concluded in the first order that plaintiffs had included sufficient facts to satisfy R u le 9(b) and to support a strong inference of scienter, but had not alleged enough to satisfy p le a d in g requirements with respect to economic loss ("loss causation") or reliance ("transaction c a u s a tio n " ). Plaintiffs now have identified a plausible theory of reliance to accompany the facts of the a l le g e d fraud. According to plaintiffs, the Fund relied on the "integrity" of the Fund trades when a g r e e i n g to accept defendant's purchases and sales of Fund shares; at any time, the Fund could

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h a v e said "no" (and eventually it did), but it did not because it believed that the trades were l e g it im a t e . W h e r e plaintiffs fall short is with their theory of loss causation. First, plaintiffs were u n a b l e to generate the factual allegations deemed necessary by this court in its first dismissal o r d e r . Plaintiffs were told that they would have to include facts tying the Fund share trades a l l e g e d l y coordinated by defendant to increased stock trading activity. Id. at 10. This required t w o things: (1) "detail[ing the Fund's] trading on the open m a r k e t for any given day"; and (2) " d e s c r i b [ i n g ] whether that trading was related to [the Fund's] obligation to maintain a certain c a s h balance range." Id. Plaintiffs have included allegations about the Fund's daily trading on t h e open market, but do not identify which of those trades were "forced" by the alleged cash to s t o c k ratio imbalances that defendant caused. B e c a u s e plaintiffs' theory is that defendant "induced a disparity" between the stock price a n d its true value, plaintiffs must allege facts explaining how defendant's acts induced this alleged p r ic e disparity. Plaintiffs allege generally that they were "forced" to buy and sell stock on the o p e n market at market prices, but they do not explain when their trades were "forced" and when t h e y were discretionary. This leaves a disconnect between stock price fluctuations and Plaintiffs' allegations suggest that trades by

d e fe n d a n t 's coordinated Fund share trades.

d e fe n d a n t and his alleged co-conspirators comprised a majority of all trades of Fund shares, but t h i s would matter only if the Fund were required to wait until Fund shares were bought or sold b y other traders before the Fund could trade on the market. Plaintiffs allege nothing about how m u c h trading the Fund performed independently, but their newly-submitted chart shows the F u n d ' s independence: it would buy or sell stock shares after defendant and the alleged coc o n s p ir a t o r s had done the opposite. For example, on June 22, 2009, defendant and alleged co-

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c o n s p ir a t o r s first bought about 600,000 Fund shares then sold about the same amount the next d a y ; in the days following that sale, however, the Fund bought around 100,000 stock shares each d a y , three days in a row. Second Am. Cpt., Exh. B, Dkt. 50-3. S e c o n d , the Fund's own role in the scheme prevented it from becoming a victim. As I e x p la in e d in the previous order, loss causation is nothing more than "the standard rule of tort la w that the plaintiff must allege and prove that, but for the defendant's wrongdoing, the plaintiff w o u l d not have incurred the harm of which he complains." Bastian v. Petren Resources Corp., 892 F . 2 d 680, 685 (7 th Cir. 1990). The allegations must support an inference that "the defendant's a c t i o n s had something to do with the drop in value" of the stock. Ray v. Citigroup Global M a r k e t s, I n c ., 482 F.3d 991, 994-95 (7 th Cir. 2007) (citing Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 3 3 6 , 342-43 (2005)). As plaintiffs see it, the Fund took a hit because defendant and his cohorts bought Fund s h a r e s low, which led to increased market activity in the stock (because the Fund, now cashh e a v y , would have to re-balance its ratio by purchasing stock); the Fund's stock purchases would r a is e the stock price; then the trio would sell back to the Fund their recently-purchased Fund s h a r e s at the higher price (the Fund being composed of now-inflated stock and cash); this would le a d again to increased market activity (because the Fund, now imbalanced in the other direction, w o u ld have to sell stock), which would this time lower stock price, leading to another round of b u y in g Fund shares. And so on. This sounds like a good deal for defendant and his alleged coc o n s p ir a t o r s , but why is it a bad deal for the Fund? This is where plaintiffs' theory starts to b u c k le . The increased market activity would occur as a result of the Fund's trading, which means t h a t the Fund would be buying or selling at the non-manipulated price. Only after the Fund was

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f o r c e d to make its own purchases would the market price go up. The Fund isn't buying or selling i n the wake of a manipulated market because the Fund creates that wake itself (albeit as a result o f defendant's actions). The next time defendant is involved, it is in order to take advantage of t h a t manipulation by trading Fund shares, which then forces the Fund to do the same with s to c k s . O n e caveat is that the Fund had the discretion to spread out its "forced" trades over time, m e a n in g it could have put itself in its own wake. However, in that circumstance, two questions a r is e : did the Fund trade enough before the last round of trades to stimulate the market? If so, w h y would it wait to trade when facing a loss. knowing its own trades could affect prices in the s h o r t term ? In all likelihood, the Fund spread out its trades when it had reason to believe it w o u ld not take a loss, either because its single-day trades were not so large as to affect prices or b e c a u s e other market factors prom is e d better payoff with spread-out trades. Of course, plaintiffs a r e not required to show that their theory is "likely" (or even more likely than any other possible o u tc o m e ) , but they do need to offer facts to support their theory. In this case, this means the f a c t s must allow an inference that one or more of the Fund's forced trades occurred in the wake o f a previous forced trade that affected the market. As explained above, plaintiffs do not identify w h ic h of their trades were "forced" (to restore the cash/stock ratio) and which were discretionary, s o there is no way to tie any alleged market manipulation with any of the Fund's trades. Plaintiffs try to reanimate their claim sideways by adding allegations from two Fund p a r t i c i p a n t s who allegedly sold Fund shares at depressed values in the wake of defendant's a lle g e d market manipulation. There are two fundamental problems with this: First, the

p a r t ic ip a n t s ' losses result from trading Fund shares, not stocks; only purchasers and sellers of f e d e r a l securities can bring § 9(a) or 10(b) claims. 15 U.S.C. § 78i(e); Blue Chip Stamps v. M a n o r

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D r u g Stores, 421 U.S. 723, 732 (1975). Because these participants would not have a claim in the f ir s t instance, plaintiffs cannot pursue any such claim on their behalf. Second, even if these in d iv i d u a ls could bring a claim under a theory that their fund shares were tied to securities, such c l a im s would have to be for their own decisions to purchase Fund shares. There is no basis for a l lo w in g plaintiffs (on behalf of the Fund) to bring a case for other individuals' decisions to trade. A s defendant points out, the one case plaintiffs cite to support such a notion is distinguishable. I n Peoria Union Stock Yards Co. Retirement Plan v. Penn M u t u a l Life Insurance Co., 698 F.2d 320, 3 2 6 (7 th Cir. 1983), the trustee suing on behalf of plan beneficiaries was investing on those b e n e f i c i a r i e s ' behalf. In this case, the Fund did no such thing. The Fund simply traded Fund s h a r e s with the participants according to the participants' wishes. The Fund cannot pursue c la i m s on behalf of others simply because those participants used the Fund's services. I n conclusion, plaintiffs have failed to fix the pleading deficiencies that were present in t h e ir first amended complaint. The allegations underlying their federal securities claims come n o closer to supporting any inference that defendant caused the Fund to suffer a loss. Perhaps d e f e n d a n t was engaged in sharp trading practices, but they were not of the sort that are captured b y federal securities fraud claim. Plaintiffs have had ample opportunity to craft an acceptable s e c u r it ie s complaint but have not been able to do so. Therefore, I will dismiss their federal s e c u r it ie s claims with prejudice. T h is leaves plaintiffs' state law claims. They must be dismissed as well, but for a different r e a s o n . As I mentioned in the previous order, once federal claims are dismissed from a case, as a "general rule," the court should decline to exercise supplemental jurisdiction over the state law c l a i m s under 28 U.S.C. § 1367(c). W r i g h t v. Associated Insurance Companies, Inc., 29 F.3d 1244, 1 2 5 1 (7 th Cir. 1994). None of the usual exceptions to this general rule are present in this case:

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t h e r e is no indication that any statute of limitations has run on the state law claims, no judicial r e s o u r c e s have been committed to the resolution of these claims and it cannot be said that the d e t e rm in a t io n of any of these state law claims is "absolutely clear." Id. at 1251-52. Nor is there a n y other aspect of judicial economy, convenience, fairness or comity to support retaining these c la im s . Id. at 1251 (listing these as the general factors to consider in any case). Perhaps

p la i n t i f f s ' theory of liability will fit better into one of the state law claims, but that is a matter b e s t left to a state court.

ORD ER I T IS ORDERED that: 1) D e f e n d a n t 's motion to dismiss (dkt. 52) is GRANTED; 2) P l a i n t i f f s ' claim s that defendant violated §§ 9(a) and 10(b) of the Securities E x c h a n g e Act of 1934 are DISM I S S E D W I T H PREJUDICE for failure to state a claim upon which relief may be granted; 3) P l a i n t i f f s ' claim s are DISM I S S E D W I T H O U T PREJUDICE under 28 U.S.C. § 1 3 6 7 ( c ) ; plaintiffs may refile those claims in state court; and 4) T h e clerk is directed to enter judgment in defendant's favor and close this case.

E n t e r e d this 31 s t day of August, 2010. B Y THE COURT: /s / S T E P H E N L. CROCKER M a g is tr a t e Judge

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